Thursday, May 2, 2013

How the Fed creates bull and bear markets (part 2)

There
are some economists who overestimate the effect of loose money and credit in
creating market crashes. While they
correctly identify loose monetary policy as a prime contributor to a financial
market bubble, they ignore the devastating impact of a subsequent tight money
policy. Loose money doesn’t cause a
market crash by itself; it’s the combination of loose money followed by tight
money and credit conditions which serves as the catalyst for a crash.

There
is an “X-factor” to all of this, however.
While there is no sign of monetary policy tightness on the Fed’s part,
there is what might be called “policy tightness” by the world’s leading governments,
including the U.S. Congress. Fiscal
austerity current reigns supreme among U.S. and European governments and it
could eventually prove detrimental to the Fed’s efforts at continuously
flooding the system with liquidity. As
Dr. Scott Brown of Raymond James has said, fiscal tightness amounts to a
“self-inflicted restraint on growth” and that amounts to “very bad economic
policy.” It also explains why, despite
record levels of liquidity, the economy has been able only to tread water in
recent years while financial markets have soared to new heights.

Could
it be that austerity will ultimately prove to be the catalyst that kills the
recovery? The question remains
unanswered but with the downward pressure exerted by next year’s 120-year Kress
cycle bottom, a failure of Congress and other governments to admit that
austerity has been a failure could prove fatal.